Twelve surprises for 2018

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    Outperformance candidate: could South Africa's stock market be set to surprise this year?

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“In science and similar disciplines, knowledge is generally cumulative, building on a foundation of laws and relationships. In the financial world, knowledge is adaptive, in the sense that the views and actions of each participant — a function of their own experiences — affect the views and actions of others. As John Maynard Keynes put it, investors are like judges in a beauty contest where the goal is to pick not the most beautiful contestant but the contestant who is picked by the most other judges. The result is a dizzying degree of interdependence as each judge tries to guess what other judges will think other judges will do. This keeps markets in a constant state of reflexive flux, making it difficult to forecast with any degree of precision.” — The CFA Institute Research Foundation, Portfolio Structuring and the Value of Forecasting — The Perils of Forecasting by Craig Bodenstab, CFA

The quote above does a great deal to sum up the difficulty in forecasting. I’ve said this in all my prior surprise columns and I’ll say it again; static forecasting is junk.

Situations in financial markets are fluid, thus all prognostications are almost instantly stale. Trying to guess what the market will do next is like trying to nail Jell-O to a tree.

No one can truly claim with certainty that they know what tomorrow will bring and if you meet someone who does, you should put your hands in your pockets to check for your wallet and slowly back away. Voltaire sums it up best: “Doubt is not a pleasant condition, but certainty is absurd.”

Besides, successful investing involves following the right principals and prescriptions, not the right predictions. Spending inordinate amounts of time trying to predict things you can’t forecast or worrying about imagined outcomes is rarely, if ever, a productive use of mental capacity and time.

Besides, as the article referenced above also suggests, even accurate forecasts may not be helpful:

“Consider GDP growth, one of the most closely followed measures in our industry. Does accurately forecasting GDP growth give you an edge in picking stocks? Surprisingly not — looking at 183 ten-year investment periods in 83 countries, the correlation between real GDP growth per capita and real equity returns is an insignificant 0.12. How can this be?”

As Mr Bodenstab states, it comes down to the relationship between expectations and prices. Great prices rarely are associated with great expectations.

So why even bother doing forecasts? Good question.

Here are some reasons why I pen these each year. I have written these in the spirit of nudging the reader (and myself) to look “outside-the-box” and consider a disparate view of things that may cause some cognitive dissonance.

To second guess some “hard-held” beliefs and maybe consider alternate outcomes rather than be wedded to some concrete ideals that have been perpetrated by the current consensus view. The other reason, and maybe the truest, is for my readers’ entertainment.

To be clear, what follows is not an investment strategy or outright forecast but a list of potential surprises for 2018. Ideas that are not consensus based with explanations on why they have a good chance of happening.

If you see value in these, it will be the explanations that count, not the actual prediction. One should immediately be questioning this whole process given a counter-intuitive meme: how can something be a surprise if it has an above average chance of occurring? Yet another good question. Now for your consideration and entertainment …

1. Value beats growth: in the last seven out of ten years, growth has beaten value (as measured by the MSCI World Value and MSCI World Growth indices). In fact, the performance of growth stocks crushed value stocks in 2017. According to The Vanguard Group, large cap growth stocks returned 21.7 per cent and value stocks gained just 13.7 per cent last year. Mid-cap growth stocks returned 18.5 per cent and value stocks gained only 13.3 per cent. Small-cap growth stocks returned 18.3 per cent and value stocks gained just 7.8 per cent. (These figures include dividends.) The surprise will be how badly value crushes growth in 2018.

2. Transformational deal: Apple buys Netflix — adding a huge content library and moving towards streaming away from one-time purchases in iTunes. This would be a huge competitive upscale for Apple. Amazon buys a bank, major mall anchor retailer or a transportation company as it expands it physical presence. Google buys Snapchat — it’s long been rumoured that Google has a $30 billion standing offer to buy SNAP, this at least moves the company into social networking after its earlier failed attempts. At least one transformational and major tech deal such as those mentioned rocks the market next year.

3. Commodities crush it: recently, commodities have fallen to major lows relative to stocks (as measured by the S&P GSCI and S&P 500 indices). No one seems to be paying any attention to commodities right now because we haven’t seen a sustained rally throughout the commodity space in a long time. Economic catalysts should also bolster the value argument for commodities with an uptick in synchronised global growth. A weakening dollar and growing unrest in the Middle East should also help energy prices. Uranium jumps in 2018, after having a positive year only three times in the last ten. Kazakhstan and Canada’s Cameco Corp previously announced plans to reduce output and shut operations amid a global stockpile glut finally bite. Prices are still about 67 per cent below a peak in February 2011 and this commodity has been essentially left for dead.

4. Gene therapy explodes: genomics and gene therapy medicines hold the key to the global healthcare crisis. This should be the year we start to see rapid adoption and development of gene therapies that help us correct faulty genes by rewriting a human’s DNA. We have already begun the process of modifying a patient’s white blood cells to attack cancer cells but further application will accelerate more personalised medicine. Look for CRISPR companies and those involved in genetic research to perform exceptionally in 2018.

5. Despite 10 per cent correction at some point, the S&P 500 ‘melts up’: analysts have been upgrading corporate earnings estimates at the fastest pace in ten years on the back of corporate tax reform. Furthermore, disappointed with low yields and now mark-to-market losses in bond funds, investors shift further into equities. The S&P 500 will eclipse 3,000 at some point in 2018 (the average Wall Street target price for the S&P 500 is about 2,800). The most hated bull market in history becomes the most accepted.

6. Main Street lags Wall Street: despite robust employment numbers and an improving global economy, wage gains are not significant. Discussion among academics and the Federal Reserve circles around the Philips Curve and its failure to predict higher wages. Likely causes appear to be technological acceleration in artificial intelligence and other forms of automation which essentially begin the major computerisation of a huge set of tasks across a wide swath of professions. We come to realise that the gig economy is great for the platform companies but not necessarily the workers. The reality that the delta in destruction is much greater than the delta in new opportunities and productivity growth becomes decoupled from employment growth even more. Ye Xie from Bloomberg Markets Reporter notes that “19 states raised their minimum wage last year, and it didn’t cause wage inflation to soar”.

7. Cryptocurrencies crash: with increased governmental pushback and regulation and the sheer volume of new, competing bitcoin-like alternatives and coins that accelerate supply, the crypto asset cycle peaks and collapses in spectacular fashion. The surprise of the bursting bubble will be contagion that develops as unknown leverage is revealed and even some mainstream companies suffer. Remember, in the early 2000s one of the factors leading to the collapse of dotcom stocks was the sheer number of IPOs and, as a result, the dramatic increase in supply of stock.

8. South Africa is super: South Africa is one of the cheapest stock markets in the world on a cyclical adjusted price earnings ratio. It also is most likely one of the most controversial given its turbulent history and politics. Plus, recent scandals at Steinhoff International, a company listed in and headquartered in South Africa are only adding to the overall uncertainty. But as stated above, bad news can often lead to great prices. South Africa becomes one of the best equity markets in 2018.

9. The bond bull market ends: although some prominent bond managers have recently called for this, it is nowhere near consensus. Yields exceed estimates as the ten-year US Treasury security breaches 3.25 per cent at some point. (Note: only about 10 per cent of estimates I can see on Bloomberg estimate yield ending above 3.25 per cent). Asset allocation is turned upside down and bonds “appear riskier” than stocks as credit spreads also widen and pull down even higher quality bonds.

10. Bermuda stumbles: GDP mean-reverts slightly back to trend. Growth posts a modest loss on tough comparisons — 2017 was America’s Cup — and an insurance industry undergoing an “existential crisis”.

11. Populism loses and wins: despite calls for “change” and growing discontent with Republican polices, not to mention the party’s clueless, fearless leader, the Democrats actually lose positions in the Senate. Democrats’ call for a major overhaul are ignited and the party desperately searches for new leadership to spearhead a “new day” by a celebrity leader. Jeremy Corbyn becomes the new leader in the UK after Brexit turmoil frustrates the masses.

12. Dollar drops: there are reduced economic cycle differences between other major markets like Europe and the US. Near-term fundamentals are positive, based on real exchange rate differentials for the Japanese yen, which is very cheap historically speaking, and remains a safe haven flow. Despite yield differentials, monetary policy divergence narrows and the dollar weakens overall versus major currencies.

Sources

The CFA Institute Research Foundation, Portfolio Structuring and the Value of Forecasting — The Perils of Forecasting by Craig Bodenstab, CFA ( https://goo.gl/5xN4zu )

Nathan Kowalski CPA, CA, CFA, CIM is the chief financial officer of Anchor Investment Management Ltd and the views expressed are his own.

Disclaimer: This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed may change as subsequent conditions vary. The information and opinions contained in this material are derived from proprietary and non-proprietary sources deemed by the author to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. Past performance is no guarantee of future results. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this material is at the sole discretion of the reader. Investment involves risks. Readers should consult their financial advisers prior to any investment decision. Index performance is shown for illustrative purposes only. You cannot invest directly in an index

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Published Jan 16, 2018 at 8:00 am (Updated Jan 15, 2018 at 3:51 pm)

Twelve surprises for 2018

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